This is what a long economic winter feels like

Leave it to an economist living in communist Russia to find a
pattern in capitalist countries’ economies – a pattern that
paints a chilling picture for the global economy over the next
few years.

In the 1920s, Russian economist Nikolai Kondratiev (also spelled
Kondratieff) developed a theory that prices, interest rates,
foreign trade and coal and pig iron production in capitalist
countries moved in long waves of 50-60 years. This meant that
“great depressions” were a natural part of the capitalist system,
and were followed by periods of recovery.

(Joseph Stalin didn’t like that Kondratiev’s work showed that the
evil capitalist system wouldn’t collapse because of the Great
Depression that started in 1929. So he sent Kondratiev to the
gulag. He was executed by firing squad in 1938.)

In 1925, Kondratiev published a book called The Major
Economic Cycles. In it, he overlaid his theory on the
economic history of a few western nations. He found that his long
waves of economic expansion and contraction matched almost
perfectly with past economic performance, starting in 1789.

He then applied his theory to predict future economic cycles. So
far, what he’s projected has been startlingly accurate. His idea
was refined over the years and it was named the Kondratiev Wave
(or K-wave) in his honour.

The cycles in the K-wave are driven by a range of factors,
although what matters most is a subject of debate. Investment
profits, population growth, war, the relationship between
agriculture and industry, prices and technology are central to
the cycles. Debt buildup, and debt repudiation, are also key.

Some economists say that the 50-60-year cycle of the K-wave is a
natural part of any economy, and that long-term cycles of
expansion and contraction are just part of how the world works.

The K-wave seasons
The Kondratiev Wave theory has been refined over the years and
was divided into four phases: Spring, summer, autumn and winter.

Spring is characterised by an economic upswing (coming out of the
winter phase), rising inflation and by technological innovation
and development helping drive productivity.

The summer phase includes the boom times – and often ends in war.

Autumn is the plateau phase. There may be a speculative boom and
market euphoria that leads to a stock market crash.

Then there’s winter, which is characterised by deflation,
economic depression, high levels of bankruptcy, and unemployment,
as debt is “cleansed” from the economy. (Kondratiev felt
depressions were good for cleansing the system of excess.)

And, according to Kondratiev Wave adherents, that’s the season
we’re in right now.

The winter phase began in 2000 (right around the time of the
NASDAQ/tech crash). Based on past history, most winters last 20
years. That would mean we’re still in for another few years
of tough economic times.

But what do the facts tell us?
The winter phase includes deflation, a troubled financial system,
collapsing commodity prices (except gold, which goes up), rising
interest rates, currency crises, a bear market for stocks and a
cleansing, or repudiation, of debt.

The financial system is struggling. As we’ve recently written,
the latest potential casualty is Deutsche Bank, Europe’s largest financial
institution.

Commodity prices have fallen over the past several years as
demand has not been keeping up with supply.
The S&P GSCI Total Return Index, an index that reflects
global commodity prices, is down 52 percent for both the past
three and five years.

(One exception to this is gold. Gold prices are up over 200 percent since the
end of 2000. Gold demand has surged as concerns over the global
economy grow.)

There have been a number of currency crises, such as in
Venezuela. And the euro is arguably in a permanent currency
crisis.

What about deflation? Japan is already dealing with it and it’s
rearing its head in Europe. The U.S. also flirted with deflation
at the height of the 2008-2009 financial crisis. But crushing
global deflation is not yet an issue.

A few elements of the K-wave Winter period, such as rising
interest rates, a bear market, and debt repudiation, are missing
from the picture.

Interest rates are close to zero in most major economies, and
some have even gone negative. Stock markets did crash in
2008-2009, and some entered bear market territory briefly earlier
this year – but there’s no global bear market in equities.

And no one is repudiating debt (yet). Instead, the global economy
is borrowing more. Since 2000, the world’s total debt load has gone upover 130 percent.
It’s now more than US$200 trillion.

But the lack of global deflation, low interest rates, relatively
strong stock markets and massive amounts of debt are all related
to one thing – the world’s central banks’ interest rate policies.

How low interest rates are affecting the K-wave
cycle

Central banks have cut interest rates as much as they can to try
to stimulate economic growth – and to prevent the depression
usually associated with a Kondratiev Wave winter.

Low interest rates promote inflation, rather than deflation. When
rates are low, people and countries take on more debt – the
system certainly isn’t cleansed of it. And low interest rates are
generally good for stock markets.

Central banks may be interfering with the natural “cleansing” of
debt and excess that should happen to economies every 50-60 years
– and that’s been happening for the past 1000 years. If that’s
the case, government interference is delaying the “spring” boom
that follows the K-wave winter.

One way to insulate your portfolio from any coming volatility, or
a Kondratiev winter, is to buy gold.

As we’ve written about a lot, gold is a safe-haven asset. It’s one of the
oldest forms of money, it holds its value when stock markets
crash and is recognised worldwide as a store of value.

So if the worst of winter is indeed coming, owning gold will pay
off.

We again recommend owning an ETF to invest in gold. The SPDR Gold
Trust ETF can be purchased on the Singapore Exchange (code: O87)
and the New York Stock Exchange (ticker: GLD). For investors
using the Hong Kong Exchange, try the Value Gold ETF (code:
3081).